Risky Bank Debt to Recover When Sales Resume, CreditSights Says

The riskiest bank securities will probably recover from last week’s record slump after European lenders resume issuance when stress tests are completed in November, according to CreditSights Inc. strategist David Watts.

The average price of contingent convertible bonds, which are designed to incur losses without defaulting, fell to 102.31 cents on the euro on Friday, Bank of America Merrill Lynch index data show. Yields on CoCos jumped to 6.19 percent, the highest since Feb. 4.

The selloff followed a decision by U.K. regulators to ban sales of the debt to individual investors a week after Bank of America Merrill Lynch said it will exclude the securities from its indexes. The slump was probably exaggerated by thin trading and a lack of supply, as well as losses on Banco Espirito Santo SA’s junior bonds, Watts wrote in a note to clients.

“Supply will probably be patchy and restricted to the highest-quality banks until the stress test is out of the way by early November,” according to Watts.

The European Central Bank is reviewing the assets of lenders before it takes over as the region’s banking supervisor in November. Banks will also be tested to ensure they have enough capital to withstand a crisis.

Junior bonds of Lisbon-based Banco Espirito Santo were left behind when Bank of Portugal moved the lender’s best assets to Novo Banco as part of a 4.9 billion-euro ($6.6 billion) rescue that began last week.

CoCos can be written down or converted to shares if an issuer’s capital falls below a pre-determined level.

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